This research paper examines the position of the observed real exchange rate (RER) in relation to its unobservable equilibrium position, estimating the time path of the latter using the single equation procedure. It found out that over the sample period, real exchange rate misalignment (measured as the deviation of the actual from the estimated equilibrium path) was irregular but persistent. Misalignment was also found to be higher during the period of deregulation than during that of regulation. After generating the misalignment and volatility of the RER, this work proceeded to ascertain the influence of these distortions on the balance of payment – a gauge of the external balance position of the country. It was then observed that real exchange rate distortions (misalignment and volatility) hurt both the trade balance and the capital account. However, while RER misalignment is critical to the two external sector variables, volatility matters more to the flow of capital. The paper therefore recommends a more realistic management of investment environment (with an eye on stability), public sector expenditure and other fundamentals as a necessary complement to nominal devaluations in the search for stronger external positioning.

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